Loss severities on distressed residential mortgages are likely to rise this year as several key government support programs expire, Fitch Ratings says.

Low mortgage rates, home buyer tax credits and government directed loan modification programs have led to an improvement in home prices and loss severities since last year's second quarter. However, the expiration in the coming months of both the tax credit and the Federal Reserve's $1.25 trillion mortgage-backed securities purchase program will increase negative pressure on home prices, according to Grant Bailey, a senior director at Fitch.

Additionally, an increase in the liquidation of loans with unsuccessful loan modifications is expected to add to the supply of distressed inventory in the housing market.

"Servicers are further along in identifying borrowers ineligible for modifications and will likely be more aggressive in liquidating those loans this year compared to last," Bailey says. "Less costly alternatives to foreclosure, such as short sales, should help stem rising loss severities due to the lower costs and speed of the resolution."

Loss severities on loans resolved through short sales are approximately 10% lower than loss severities on loans in which the servicer takes possession of the property, according to Fitch.

Fitch also notes that the expected seasonal increase in housing activity through the summer may delay the full impact of the withdrawal of the government support programs until later this year.

Loss severity trends continue to be strongly dependent on home-price trends. In the two years prior to the recent improvement, national home prices dropped approximately 30%, while loss severities on loans that incurred losses doubled to record highs of 43% for private-label prime loans, 58% for Alt-A loans and 72% for subprime loans, Fitch says.